Higher interest rates a positive and a negative for consumers

The EY ITEM Club forecast presents a mixed picture for consumer spending, which is expected to benefit from several supports. Although pay growth is expected to ease, inflation should decline more quickly. Falling energy bills, easing food price inflation and weaker pipeline price pressures mean inflation is predicted to average 7.4% this year (down from July’s 7.6% forecast), before falling to 2.9% in 2024 (down from 3.4%) and 1.7% in 2025.

Meanwhile, the EY ITEM Club estimates that higher interest rates have, so far, been a net positive for household incomes with the income boost from higher rates on savings accounts exceeding the extra amount spent on mortgage interest payments. But this picture is set to reverse as deposit rates stabilise and more and more borrowers roll over fixed rate mortgages onto higher rates.

Consumers will also feel pressure from higher oil prices, the combination of frozen income tax thresholds and still-high inflation, and a deteriorating labour market. Unemployment is now forecast to peak at 4.8% next year, up from July’s forecast of a 4% to 4.5% peak in 2023.

Taking these supports and pressures into account, consumer spending is now expected to grow 0.7% this year (an upgrade from the flat 0% expected in the Summer Forecast), another 0.7% in 2024 (slightly up from 0.6%) and 1.7% in 2025 (no change).

Martin Beck, Chief Economic Advisor to the EY ITEM Club, said “While recent industry surveys have been fairly gloomy about the UK economy, there have been enough positive developments, including upwards revisions to past data, to lift the mood music and reduce the danger of recession becoming a self-fulfilling prophecy. There are still prominent risks to the forecast though, including potential volatility in both oil and gas prices and tighter financial conditions. And, with an election approaching, the future path of government fiscal policy isn’t clear beyond 2025, presenting a significant unknown to the longer-term forecast.”

The EY ITEM Club continues to expect house prices to fall by around 10% from their highest to lowest points, with a flatlining expected in 2023 before a 4% fall in 2024 as high borrowing costs apply downward pressure on demand. The market is still expected to avoid a serious price correction, helped by forbearance from lenders and the fact that the ratio of house prices to average incomes has fallen.